A man has been decapitated by attackers brandishing Islamist flags at a French factory near Grenoble.
The severed head had Arabic writing scrawled across it and was found on a fence next to two jihadi banners.
Two other people were hurt in explosions at the factory, French President Francois Hollande said.
The blasts were triggered when two attackers deliberately crashed a car into gas canisters, according to police.
The main suspect, named as Yassin Salhi, 35, has been arrested.
He is believed to have been an employee of the victim - who headed a local transportation company, according to a French security official.
Salhi's wife Yacine is also thought to have been detained as French television showed a woman and another person being led away from the suspect's apartment in a suburb of Lyon.
Earlier, Yacine told radio station Europe 1: "We are Muslim. We observe Ramadan...We have three children. We live a normal life."
Salhi's sister and one other person are also in custody.
Le Parisien reported gunshots and that one Islamist had been killed at the premises in Saint-Quentin-Fallavier, southeastern France.
Le Dauphine newspaper reported that police are hunting for another man.
Interior Minister Bernard Cazeneuve, speaking from the scene, described the attack as "barbarous" and a "terrible terrorist crime".
He said that one of the suspects had been known to foreign intelligence services may have been radicalised.
The suspect was initially flagged as an extremist in 2006 and then police monitoring dropped off two years later, according to Mr Cazeneuve.
He did not have a criminal record, the minister added.
Mr Hollande has cut short all of his engagements at the EU summit in Belgium to return to France for emergency talks.
He spoke before leaving Brussels.
Journalist Peter Allen is in France. He told Newstalk Lunchtime there are fears of more attacks.
The first video from the scene has emerged, from France TV
#Isère Nos confrères de @France3tv nous ont transmis les premières images de l'usine attaquée pic.twitter.com/G77UiOItzQ
— francetv info (@francetvinfo) June 26, 2015
"The president saw the first images of the attack on the 24-news channels with German Chancellor Angela Merkel beside him, who was visibly shocked," an official added.
The two leaders had just ended a short meeting with Greek Prime Minister Alexis Tsipras.
Employees at the factory - Air Products - are said to be "very shocked".
One witness called Caroline, from a neighbouring factory, said: "I heard a really loud noise. Fire engines arrived with the police. We thought it was a motorway accident."
The attack occurred in the south east of France, close to the city of Lyon
Air Products is an American chemical company based in Allentown, Pennsylvania.
A statement from the company read: "Our priority at this stage is to take care of our employees, who have been evacuated from the site and all accounted for. Our crisis and emergency response teams have been activated and are working closely with all relevant authorities."
The attack came nearly six months after the Islamist attacks in and around Paris that killed 17 people in January.
Those attacks started with a shooting at satirical magazine Charlie Hebdo.
French Prime Minister Manuel Valls said security was being tightened at "sensitive sites" in response to the attack.
